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Real Exchange Rate Decompositions

Bruno Feunou, Jean-Sebastien Fontaine and Ingomar Krohn

No 2022-6, Discussion Papers from Bank of Canada

Abstract: We provide a novel daily decomposition of the real exchange rate that exploits a direct link between bond and foreign exchange (FX) markets. Real exchange rate dynamics can be attributed to changes in the expected future level of the exchange rate; cross-country differentials of expected inflation, yields and bond term premia; and an FX risk premium. Through a variance decomposition exercise, we fi nd that the FX risk premium is the dominant component. Monetary policies and macroeconomic news announcements largely move the real exchange through changes in the FX risk premium.

Keywords: Asset pricing; Exchange rates; International financial markets; Monetary policy transmission (search for similar items in EconPapers)
JEL-codes: E43 F31 G12 (search for similar items in EconPapers)
Pages: 48 pages
Date: 2022-03
New Economics Papers: this item is included in nep-cba, nep-ifn, nep-mac, nep-mon and nep-opm
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